Blog November 20, 2019 Rohan Narula

Assess And Resolve: Risk Management In Wealth Advisory Sector

Risk is conjoint with returns in the investment realm and risk management is practised across the financial sector. Stockbrokers implement risk management when handling financial instruments such as futures and options, portfolio managers strategize to mitigate risks, and asset managers exercise risk assessment and treatment for effective management of assets. Identifying, analysing and mitigating the risks involved in investment decisions are what make up the risk management field. 

Incompetent management of risks can lead to severe repercussions for industries, individuals and the economy. For instance, the subprime mortgage meltdown, that helped set off the ‘Great Recession’, that occurred between 2007 and 2010 originated from inadequate risk management and poor decisions[1] mortgages were offered by lenders to those with poor credit score, investment firms associated themselves with these mortgages, and excessive funds were invested in the repackaged mortgage-backed securities (MBS). The ‘Great Recession’ is considered the most severe economic disaster that plunged the global economy to pits. 

Moving forward post the ‘Great Recession’, as the economy started recovering from the crisis, a shift in the attitude towards risk management was noted as per a PwC report[2] . The report highlights a change in behaviour that places “risk management, transparency and sustainability at the forefront.”

A Panoramic View On The Current Landscape

The landscape of risk management is continuing to evolve and risk managers find the traditional models[3], such as beta, standard deviation, VaR and CVaR, used for assessing risks to be inadequate. Establishing new and advance models and frameworks is one of the current macro trends in the financial sector. This ensures that risk management practices are on par with the volatile and agile landscape of investment and wealth management. 

Risk managers, wealth advisors and wealth management institutions should be capable of providing solutions and answers to the various issues, including topics related to increased fragmentation, complex regulatory frameworks and the changing client expectations.

As pronounced by a BCG report[4], below are the answers to 3 key questions for the financial institutions:

  1. How can an institution efficiently manage its financial resources?

    As financial institutions employ capital and maintain liquidity, they must adhere to strict regulatory requirements. At the same time, they need to find the best opportunities to earn a return and satisfy shareholders.

  2. How can the effectiveness of risk management be improved?

    Companies should continually evaluate whether their risk management procedures are adequate. As requirements change, financial institutions have to consider the implications for governance, systems, and infrastructure.

  3. How can an institution manage its biggest risks?

    Financial institutions first need to identify their biggest risks. Once identified, those risks must be understood and managed at every level.

A brief compilation[5] is presented below, of the various risk management facets that have emerged to effectively navigate the rapidly evolving sector of wealth and investment management. 

  • Big Data And Analytics For Risk Management

Risk managers consider several areas when it comes to managing risks by employing advanced analytics and Big Data — data quality and control, transactional life cycle completeness, service provider transitions, data interchanges and impact of mergers and divestitures on data. Analytics paves the way for real-time assessment and a more comprehensive view of the financial situation, allowing for adjustment of risk management models without much delay. The main drawbacks of analytics usage are its complexity and availability of sufficient resources. Investment and risk managers need to attain a thorough understanding of this field to efficiently identify and mitigate any issues.

  • Managing Privacy And Cybersecurity

Today, data breach and hacking have become commonplace such that they are almost expected to occur. Financial institutions are at the front line of facing cybercrimes. Cybersecurity tops the agenda of regulatory bodies. New laws on privacy and cybersecurity are being introduced to handle situations and prevent further occurrences. Several countries are implementing new regulatory norms or enhancing their existing regulatory requirements.

  • Integrated Risk Management And Compliance

Investment and wealth management companies function in a complex business environment that is subject to multiple regulations. In such conditions, managing risks should no longer be an isolated function, rather integrated risk management and compliance approach should be adopted to offer sufficient support to business strategy and nurture business value. Many financial institutions are deploying operating models on technology platforms, which encompass the integration of risk management and compliance. They are gaining new and more detailed insights from these platforms to accelerate the model efficiencies and gain the expected benefits.

  • Conduct Risk

The concept of ‘conduct risk’ gained traction after the financial crisis. In order to identify, manage and monitor conduct risk, institutions started establishing necessary frameworks. Globally, there has been a surge in interest in the conduct and culture-based agendas, which indicates that this facet of risk management is likely to persist. A number of industries are trying to internalize the concept of conduct risk and they are figuring out ways to prevent employee misconduct as well as manage cultural implications of such misconduct.

  • Model Risk Management (MRM) Programs

In order to channelize the benefits of process-driven analytics and human insights for the enhancement of strategic decisions, wealth and investment management firms are undergoing transformations. The drive to mitigate risks and make effective decisions has led wealth and investment managers to use models in their decision-making process. An efficient MRM program will help reduce the occurrence of mistakes that could have resulted in monetary and economic loss.

The Actions Taken And The Anticipated Future

Wealth advisors and asset managers are increasing their focus on risk management and are adopting strategies that involve the measurement and reporting of risks. BCG’s report[6] suggested adopting a comprehensive framework for risk management. This report highlighted the Global Association of Risk Professionals’ (GARP) effort on “establishing a common language and a set of principles that provide a development path for firms”.

The current practices amongst asset and wealth managers are:

  • Defining controls and processes for risk management
  • Accepting and utilising technology for risk management
  • Enhancing transparency with the changing customer needs

Managing risks involve not only re-examining the operational models but also introducing necessary changes and adopting advanced tools to establish an enhanced format of basic operation.

Given the rapid evolution in technology and business-scape, a BCG report[4] talks about banking on digital chief risk officers (CROs) in the foreseeable future. Risk management leaders will lean on virtual boardrooms with powerful dashboards that are user-friendly and capable of stimulating and stress-testing potential strategies. Predictive modelling tools will help in early identification of operational, cyber, financial and compliance risks. Considering the advance and unique skill requirements and the corresponding outcomes, digital CROs could become the core of digital transformation and growth in wealth management institutions. 

Disclaimer: This blog is published for educational purposes only and does not constitute investment, legal or tax advice or a recommendation or an offer for risk management in any market, territory or country. Please consult a professionally certified tax or financial advisor for any investment related decisions. All views contained in this blog are the personal opinions of the author based on publicly available research and news.
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